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In our Investment Market Review, we discuss the fall in the markets in the fourth quarter of 2018 and whether the recent sell-off is justified or an over-reaction to fears of recession. Over January markets are in general up on the December close but no one knows what the next short term move in valuations will be. What we do know is that the market volatility that has been experienced in the past few months is not unusual from a historical point of view. We have seen market declines and subsequent recoveries regularly occur in the past. In fact, post WW2 data confirms that the US market has a decline of 10% or more on average every 18 months with recovery times after a sell off usually within a period of months rather than years.

The recent volatility comes after an unusually stable and prolonged period of strong share market returns. Accordingly, we take the opportunity in this report to remind clients of the fact that investors are rewarded for bearing market risk (volatile periods) over long horizons. Past evidence confirms that staying the course with an appropriately weighted portfolio for your circumstances is required to harness these long run rewards.

News headlines last Friday highlighted a drop in world markets. Markets have recovered somewhat since last week’s drop and while we plan for volatility in our modelling, it is never welcome, but it is anticipated from time to time.

To put it in context, global share market volatility in the past week saw valuations down since the start of the month partially offsetting the gains of the previous twelve months. Our assessment is that this has been a sentiment driven sell-off with markets digesting a range of issues over the last week; among them rising interest rates in the United States, trade concerns, and apprehension about profit margins as we enter the third quarter reporting season this week.

However, looking through this volatility, there are a range of underlying fundamentals that remain positive for global markets. Three key themes underpin share market valuations: • Economic growth: leading surveys and leading indices point to further expansion. Markets have historically fallen in reaction to the fear of recession and presently traditional recessionary indicators are not present (such as interest rate credit spreads, significant inflation or inversion in yield curves). • Earnings growth: company forecasts still remain positive with expectation of further growth over the next 12 months; and • Valuations: the MSCI global share market index is now valued at 14.7 times annualised company earnings. This is 10% below the long run average multiple of 16.

Whilst further bumps in markets will inevitably occur, our client portfolios are highly diversified, and the overall portfolio weighting is based on individual risk tolerance and objectives. This long-term strategic approach to investment is supported by substantial evidence as we position for both stable and volatile markets.

In our Investment Market Review we discuss the continued theme of positive performance of equity markets, notwithstanding trade tensions on the global stage. The NZD continues to weaken, bolstering returns of unhedged global securities.

We also comment on the Australian Royal Commission’s enquiry into misconduct in the Australian banking and financial services sector. This underscores the merit of truly independent advice to protect clients from the conflict of interest implicit in some advice channels.

Our June Quarterly Report reflects on recent market movements, the risks posed by potential trade wars and the concentration of NZ market performance. We also examine the effect on house prices of the marginal buyer and consider the impacts of lower net migration and restrictions on foreign buyers on the housing market.

In our Investment Market Review we discuss the recent reversal in the equity markets and the outlook, which we believe is still positive, despite concerns over trade protectionism. Over the last quarter, fixed interest markets have been broadly flat whereas equity markets have experienced a sell-off, but this is in the context of a very good performance over the past year. The outlook for global growth remains good.

Our client education piece for this month draws on a recent study of active manager underperformance vs benchmark and compares the benefits of enhanced portfolio strategies in comparison to a single sector index strategy.

The fall in the value of shares in the USA and other markets has hit news headlines this week suggesting it to be a dramatic turn of events. In fact, whilst the initial 6% fall in any day is large in isolation, the event is not extreme in the context of market fluctuations often seen along the path that generates long term returns.

As we noted in our quarterly commentary for the period ending 31 December, investors were favoured with unusually smooth and strongly positive returns during 2017. In this context the recent fall is well within the ‘normal’ range and the pullback has for the most part merely reversed the added gains of January 2018 returning values towards the closing prices of 2017.

Financial theory teaches us that risk and return are related, and that we get a premium for taking risk. Once we diversify out concentrated risks, that do not offer extra reward, we are left primarily with market risk expressed as volatility. That is, markets will have occasional set-backs on the upward path of value creation arising from corporate profits and economic growth. In this context the sporadic downturns are just as important as the uplifts, because without them there is no risk, and without risk there is no premium, and then we only achieve the cash rate of return, which for most of us is not enough.

It is natural to feel some emotion from the set-back that even a temporary fall in market value may provoke. However, I am reassured by the process we use to manage your money and the confidence I have in it, to deliver returns over time in keeping with your objectives. This process includes taking a measured amount of risk, with the knowledge that it comes with occasional blips in market value, that we ultimately need because it is linked to the premium we seek.

In our Investment Market Review we discuss the strong equity market performance over the past quarter and the continuing strong global growth forecasts for 2018, aided, in part by the large cut to corporate tax rates in the United States. Over the quarter and for the past 12 months, all asset classes have performed well and posted positive returns.

Our client education piece for this month discusses the benefits of using independent expertise to provide oversight and monitoring of the performance of fund managers.

Over the quarter we saw continuing good returns from equity markets that have performed strongly over the past 12-months. On the flip side fixed income continued to struggle, but also posted positive returns for the quarter.

Our client education piece for this month reviews the fundamental problem with any notion of Market Timing. Predicting when to exit and re-enter the market is fraught with difficulty and runs the very real risk of missing out on large upside gains as markets rally.

"You have an idea. It feels like a really good one. What happens next? Believe it or not, all ideas – whether good or bad – go through an epic journey. A true idea odyssey. And in the end, only the elegant survive."

Warren Buffett, the "investment guru", made a bet a decade ago that passive funds would outperform hedge funds.

Currently he estimates that about $100 Billion has been wasted in the US from active hedge funds. This is not only from the average under-performance of these hedge funds, but also from the high fees they charge investors, which offsets much of the profit for the investment portfolios, to the benefit of the hedge fund managers.

He will almost certainly win the bet when it ends in December, with proceeds going to charity.